Chapter 11 Stockholders’ equity © Cambridge Business Publishers

Corporations A corporation is a legal entity. The founders of a corporation prepare and file the articles of incorporation which define its structure, purpose, and authorized stock. If approved by the government, the founders next elect a Board of Directors and adopt the corporation’s bylaws. In order to obtain the funds needed to begin operations, the corporation issues (sells) capital stock to stockholders (owners of the corporation). © Cambridge Business Publishers

Corporate Stakeholders © Cambridge Business Publishers

The Corporate Form—Advantages Separate legal entity Limited liability Transferability of ownership Continuity of existence Capital raising capability Capital raising capability is primarily the result of two of the other advantages, specifically limited liability and transferability of ownership. © Cambridge Business Publishers

The Corporate Form—Disadvantages Organization costs Taxation Regulation and supervision © Cambridge Business Publishers

Select the correct answer. Each of the following is an advantage of the corporate form except: Limited liability Transferability of ownership .Taxation Capital raising ability © Cambridge Business Publishers

Par Value Stock (also called face value or stated value) Of little significance today May have some legal implications concerning minimum issuance prices Legal capital—the minimum amount of contributed capital that must be maintained Usually set at a very low amount such as $0.01 (1 cents) Not related to market value or issuance price No-par value stock is permitted in many states meaning that companies can issue stock with no-par value. © Cambridge Business Publishers

Capital Stock Authorized shares The maximum number of shares that may be issued Issued shares Shares that have been sold to stockholders Outstanding shares Issued shares that have been issued and remain in the hands of stockholders rather than having been purchased back by the corporation Treasury Stock are those shares acquired or reacquired by a corporation © Cambridge Business Publishers

Common Stock The most basic type of capital stock If only one type present it will be common stock Has voting rights on corporate matters Shares in the corporation’s net income through dividends Has a preemptive right to purchase new shares to maintain proportionate ownership in the corporation Has a residual claim on corporate assets in the event of a liquidation © Cambridge Business Publishers

Preferred Stock Dividend preference Asset distribution preference Entitled to a dividend before common stockholders If cumulative, then any dividends in arrears must be paid to preferred stockholders prior to common shareholders receiving any dividends (Dividends in arrears are dividends omitted in past years to preferred stockholders) Asset distribution preference Preference over common stockholders in corporate liquidations Other potential features Convertible into common stock Participating in special dividends Callable by the corporation © Cambridge Business Publishers

Select the correct answer. Which of the following applies to common stock relative to preferred stock? .Voting rights Shares in the corporation’s net income Dividend preference Both A. (voting rights), and B. (shares in the corporation’s net income) © Cambridge Business Publishers

the accounting for issuances of capital stock. © Cambridge Business Publishers

Stock Issuance Assume Lester Corporation issues 100 shares of $100 par value preferred stock for $13,000 and 100 shares of no-par (and no stated value) common stock for $3,000. Cash 13,000 Preferred stock 10,000 Paid-in capital in excess of par value—preferred stock 3,000 To record issuance of preferred stock. Cash 3,000 Common stock To record issuance of no-par common stock. © Cambridge Business Publishers

Learning Objective 5 Stock splits. © Cambridge Business Publishers

Stock Splits A forward stock split increases the number of outstanding shares and proportionately reduces the price of the stock. No stockholder equity accounts are changed. For example, Savanna Corporation issues a 2 for 1 stock split on its 2,000 outstanding $1 par common stock. [Common Stock account = $2,000] Following the split Savanna will have 4,000 outstanding shares at $0.50 par-value common shares. [Common Stock account = $2,000] A reverse stock split increases the companies par value and reduces the outstanding shares. © Cambridge Business Publishers

Learning Objective 6 Treasury stock. © Cambridge Business Publishers

Treasury Stock Treasury stock are shares of stock that the corporation owns; stock that is acquired for purposes other than retiring them. (for purposes such as reissuing them to officers or employee stock sharing plans) Kitzer Corporation acquires 200 shares of its common stock for $15/share. Kitzer later resells 100 shares of its treasury stock for $20/share. Reported as a reduction of equity on the balance sheet. Treasury stock 3,000 Cash To record the purchase of 200 shares of treasury stock. Cash 2,000 Treasury stock 1,500 Paid-in capital—treasury stock 500 To record the sale of 100 shares of treasury stock. © Cambridge Business Publishers

Cash Dividends Dividends represent a distribution of assets or shares of stock from a corporation to its shareholders. Cash is the most common form of dividend asset distribution. Dividends are not required to be paid by a corporation, however they become a liability once they are declared. Note that dividends are not considered an expense and do not appear on the income statement, instead they are a direct reduction of retained earnings. Cash dividends 1,000 Cash To record payment of cash dividends. © Cambridge Business Publishers

Stock Dividends Dividends may also take the form of a stock distribution. While the recipient of a stock dividend does receive additional shares of stock, their proportionate ownership in the corporation, and therefore their wealth, does not change. Stock dividends are accounted for as a transfer of a portion of retained earnings to the paid-in capital account, therefore total stockholders’ equity remains unchanged. © Cambridge Business Publishers

the statement of retained earnings and the statement of stockholders’ equity. © Cambridge Business Publishers

Statement of Retained Earnings The statement of retained earnings provides an analysis of the changes in the retained earnings account for a given accounting period. Typical changes to the retained earnings account are the addition of net income or the reduction of a net loss, and a reduction for dividends. © Cambridge Business Publishers

Statement of Stockholders’ Equity Most corporations integrate the information regarding retained earnings into a more comprehensive statement of stockholders’ equity. The statement of stockholders’ equity shows an analysis of all stockholders’ equity accounts for the accounting period. © Cambridge Business Publishers

the return on common stockholders’ equity, dividend yield, and dividend payout ratio © Cambridge Business Publishers

Analyzing Stockholders’ Equity A financial ratio of particular interest to common stockholders is the return on common stockholders’ equity. This ratio measures the profitability of the common stockholders’ investment in the company. The higher the ratio, the higher the profitability of the common stockholders’ investment in the corporation. Return on common stockholders’ equity = (Net income – Preferred stock dividends) Average common stockholders’ equity © Cambridge Business Publishers

Analyzing Dividends Policy Some investors prefer receiving current income in the form of cash dividends and some investors rather the corporation not pay dividends so that the stock will appreciate more. One measure of the dividend policy of a corporation is the dividend yield. The dividend yield measures the rate of return in cash dividends from an investment in the company’s common stock. Dividend yield = Annual dividend per share Market price per share © Cambridge Business Publishers

Analyzing Dividends Policy The dividend payout ratio measures the percentage of the net income available to common shareholders that is paid out as dividends. Growth companies typically have low dividend payout ratios since they would rather use their cash to fund additional growth, while more mature companies, lacking growth opportunities, tend to have higher dividend payout ratios. Dividend payout ratio = Annual dividend per share Earnings per share © Cambridge Business Publishers

Select the correct answer Norma Co. reports the following for the current year: Net income $100,000; Average stockholders’ equity $400,000; Preferred dividends paid $20,000; Common dividends paid $10,000. Compute Norma’s ROE. 25% .20% 17.5% 30% © Cambridge Business Publishers

Corporate Social Responsibility CSR is sometimes seen as a competition between stockholders and other corporate stakeholders. Many companies now see CSR in a strategic sense where doing good can lead to doing well. In other words, CSR can lead to additional profits creating a win-win situation Doing Well Doing Good © Cambridge Business Publishers

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